Health Net Lags, Lowers Guidance

Zacks

Health Net Inc.’s (HNT) second-quarter 2012 operating income, which includes combined net earnings from Western Region and Government Contracts segments, came in at $15.9 million or 19 cents per share, declining substantially from the year-ago level of $71.0 million or 77 cents per share. Operating income was also lower than the Zacks Consensus Estimate of 66 cents per share.

Including a $119.4 million gain from sale of discontinued operations - Medicare PDP business sold to CVS Caremark Corporation (CVS), a $6.5 million loss from divested operations as well as services and expenses amounting to $10.8 million, pertaining to Health Net’s general and administrative cost reduction efforts, the company reported net income of $124.6 million or $1.48 per share in the second quarter of 2012, improving considerably from $58.3 million or 63 cents per share in the year-ago quarter.

The disappointing performance in the reported quarter was primarily due to higher-than-expected commercial and Medicaid healthcare costs.

The company’s total revenue improved 7.1% year-over-year to $2.84 billion in the quarter. This came marginally above the Zacks Consensus Estimate of $2.80 billion.

Total expenses increased 10% year over year to $2.83 billion from $2.57 billion.

Segment Performance

Western Region: The segment posted revenues of $2.7 billion in the quarter, up 8% year over year. Net investment income for the segment decreased to $24.7 million from $25.1 million in the year-ago quarter, while health plan services expenses increased 14.3% year over year to $2.4 billion from $2.1 billion.

Total enrollment in the segment stayed almost flat year over year at 2.6 million members as of June 30, 2012. Total commercial enrollment declined 7.4% to 1.3 million members, while enrollment in the company’s California health plan was relatively flat on a year-over-year basis. Enrollment in the tailored network products recorded a year-over-year increase of 6.5%. However, it surged 11.2% in Medicare Advantage plans.

Medical care ratio (MCR) for Health Net’s health plan services in the segment increased to 90.1% during the reported quarter from 86.9% in the year-ago quarter, while Commercial MCR deteriorated to 88.7% from 85.7% in the prior quarter.

Medicare Advantage MCR increased to 92.0% from 90.9% in the year-ago quarter. Meanwhile, Medicaid MCR was 91.3%, compared with 85.2% in the prior-year quarter.

Government Contracts: Revenues from the segment increased to $176.2 million from $171.0 million in the second quarter of 2011, while expenses also climbed to $152.7 million from $130.8 million.

Financial Update

As of June 30, 2012, Health Net had cash and investments of approximately $2.1 billion, up from $1.7 billion as of June 30, 2011. However, the company’s debt-to-total capital ratio decreased to 24.1% from 28.2% as of June 30, 2011.                    

Health Net’s cash provided from operations stood at $119.8 million in the reported quarter compared with an outflow of $100.2 million in the year-ago quarter.

Total assets of the company were $4.03 billion as of June 30, 2012, increasing from $3.74 billion a year ago. Stockholders’ equity also increased to $1.54 billion from $1.49 billion as of June 30, 2011.

Share Repurchase Update

Health Net repurchased 1.8 million shares at an average price of $24.77 from April 1, 2012 to August 1, 2012. The company had $355.4 million remaining under its current share repurchase authorization as of August 1, 2012.

Outlook for 2012

Health Net revised its guidance for fiscal 2012. Earnings per share (EPS) is expected to be in the band of $1.45 to $1.55 compared with the earlier guidance of $2.85 to $3.00. The combined Western Region and Government Contracts segments’ guidance lies between $1.00–1.10, down from $2.35–2.50. The guidance includes the impact of the high commercial and Medicaid costs as well as incremental general and administrative costs of $20–25 million incurred for the implementation of dual-eligible demonstration pilots in California.

Enrollment in the commercial business is expected to decline by 9−10%, while enrollment in Medicare Advantage and Medicaid are expected to increase by 11−13% and 7−8%, respectively. The company expects the total Western Region enrollment to decline in the range of 1% to 2%

Consolidated revenue is expected to be around $11.0−11.5 billion, while tax rate for Health Net is expected to be 30−31%. The company also expects selling cost ratio to be in the range of 2.3−2.4% and general and administrative expense ratio to be in the range of 8.5−8.7%.

Operating cash flow is expected to be about $10 million in 2012.

Peer Comparison

Health Net’s peer, WellPoint Inc. (WLP) reported second-quarter 2012 adjusted income of $2.04 per share, lagging the Zacks Consensus Estimate by a penny, but surpassing the year-ago earnings of $1.83 per share.

Zacks Rank

We retain our long-term ‘Neutral’ recommendation on Health Net. The quantitative Zacks #4 Rank (short-term ‘Sell’ rating) for the company indicates a slight downward pressure on the stock over the near term.

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